Thursday, October 22, 2009

Notes From The Fifth Annual Value Investing Congress Day 2

M3 was founded in 2007, and invests (long and short) in small and mid cap names in the US bank and thrift sector. There are 1300 publicly traded banks, and 93% have market caps less than $500 million. Stock presented his view of the current state of the banking sector:

Ghazi, who runs a concentrated long/short US equity portfolio, emphasizes proprietary, investigative research in his investment process:
• Focuses on value
• Identifies high-quality one-of- a-kind franchises
• Ensures financial strength, have excess cash, strong balance sheet, and monetizable assets
• “Kick the Tires Hard”- know what you own
• Asks: “What could cause stock to drop 30% or more, that would cause you to not want to buy substantially more?”
Ghazi presented the case for Coremark (CORE)
• Second largest distributor to convenience stores
• $300 million market cap
• $30 million net debt
• Trading at 12 times est 2009 earnings, 8 times TTM earnings
• Admits that this is a low margin business with low ROC, but is well capitalized, difficult to replace, underfollowed
• Highly fragmented industry
• Cigarette sales account for 70% of revenue, but just 29% of gross profit
• Company moving toward providing more fresh foods, which have much higher margins. This should more than supplant potentially declining cigarette sales.
• Believes company may ultimately be worth $45-$50

Sprott began by pointing out that Dow 10,000 is meaningless; we were there 10 years ago, and since then, have “accomplished nothing”. He is highly skeptical of the US banking industry, and predicts many more bank failures in the days ahead.

Sprott also took shots at the “Quantitative Easing” process being used at the Fed these days, likening it to the very dangerous practice of simply printing more money. He questioned who is buying all of the US govt debt, with issuance up 200% this year, and concluded that it’s the central banks doing all of the buying. Sprott then asked the most relevant question: “What happens when quantitative easing is done?”

Sprott believes that gold is a relevant place to invest these days, pointing out a sticky supply/demand situation, fact that more demand is consumed than produced each year, central banks have been selling as the price has risen substantially over the past ten years. He doubts that some who claim to have gold in their vaults actually do.

You can always count on Whitney Tilson to spoil the party with yet another sobering discussion of the mortgage mess. Yet, the story must be told, and Tilson, as always, does a fine job of it.

• Home prices are currently affordable, but that’s due to low interest rates and massive price declines
• Home prices rose slightly this past Summer
• However, there will be another leg down
The Stabilization we’ve recently see, is due to the following factors none of which are sustainable:
• Low interest rates
• The $8000 government tax credit to buyers (set to expire in Novemeber)
• Decline in resets
• FHA support
• Seasonality
Tilson pegs the current housing overhang at 7 million homes, which he believes is effectively 24 months of inventory. He believes that home prices will fall another 10% before we hit bottom.

Glenn Tongue presented one of the duos favorite ideas, Iridium (IRDM)
• Satellite systems
• Has 66 satellites in low orbit, 7 spares
• Enterprise value: $492 million
• Trades at just 3.8 X Ev/EBITDA
• Estimates 2009 EBITDA at $130 million
• Will launch new, more advanced satellites in 2014
• Much can be financed through internally generated cash flow, and payloads carried on the satellites for others
• Sees this as a multi-bagger

The always-interesting Ashton has been putting up some great numbers; his fund is currently #1 in the one, two, and three year periods in its category. Ashton highlighted three names at this Congress; Alleghany (Y), Lab Corp (LH) and MVC Capital (MVC), none of which has materially participated in the recent market rally. (For more on Alleghany, please see notes from the last Value Investing Congress, held in Pasadena, this past May).

Lab Corp (LH)
• #2 player in the clinical lab testing business, behind Quest
• $4.5 billion in revenue
• Market Cap $7.05 billion, Enterprise value $8.4 billion
• Estimates $670 million free cash flow in 2009, trades at 10.5 X FCF
• Share buybacks
• Has suffered due to perceptions of what “Obamacare” may do to the industry
• May be worth 15-17X FCF, or $95-$105 per share
• Centaur’s largest holding
MVC Capital (MVC)
• “Dollar trading for $.55”
• Business development company that makes debt and equity investments in small companies
• Currently has 32 investments
• Value of underlying portfolio misunderstood

Ackman closed out the Fifth Annual Value Investing Congress with the case for private prison owner/operator Corrections Corp of America (CXW):
• Not just a prison operator, but real estate; owns land and buildings at most locations
• Market Cap $2.9 billion, EV $4.1 billion
• 2009 Est Cap rate: 12.2%
• P/FCF 13.2
• Maintenance cap ex limited
• Rising crime rate, overcrowded state prisons.
• More efficient/cheaper than state run prisons
• Bought back 8.2 million share below book
• Board and management have skin in the game: own 6 million shares
• 61000 beds
• Solid management
• Worth $40-$54 per share
• Ackman’s position is passive; he owns more than 9% of the Company, but has no current intentions of activism

Ackman also suggested Realty Income (O) as a good short candidate. Believes company is overpriced, and that focus on monthly dividends as an attractive feature to investors will not last.